Futures (and cash) spreads have moved into the spotlight, with folks outside of my website now finally paying attention. Those of you who have been with me over the years know spreads have been a feature of my analysis since my time as a grain merchandiser for a couple different local cooperatives back in central Kansas roughly 25 years ago. The five years prior to that I was a commodity broker in a number of places across Kansas including (in size from smallest to largest) Lewis (my hometown), Johnson (almost as far southwest as you can go and still be in Kansas), and Wichita (“The Air Capital of the World”). As I’ve gotten older some of my best, and worst, memories of my years in the profession have to do with the subject of spreads.
For those of you relatively new to my analysis, a futures spread is the price difference between two futures contracts. For this discussion I will stick to spreads of a single commodity (e.g. corn) and a single marketing year (2020-2021). However, there is also value in intermarket spreads (e.g. soy/corn ratio spread, cash wheat – cash corn price spread, etc.) and crush (cattle) and crack (energy) spreads, just to name a few. I am also focusing on spreads of a single marketing year, acknowledging one of the most asked about is the Dec-Dec corn spread (front month of different marketing years). All of the spreads in a grain market’s marketing year is called a forward curve, while a forward curve for an energy market (e.g. crude oil) can extend indefinitely.
What do spreads show us? And yes, I chose those words carefully because of Newsom’s Market Rule #5: It’s the “what”, not the “why”. Let’s take a quick look at the close in live cattle for Friday, November 13 (see attached). The nearby December contract closed $2.05 lower while the February issue fell by $2.575. Looking out further shows us April was down $2.15, June lost $1.55, and August dropped $1.25. If I know nothing about the live cattle market, I can still describe what activity drove the market last Friday. By looking at the difference in how the December and February contracts acted, we can see the noncommercial side was selling while commercial interests were buying nearby Dec. Again, the spread narrowed by $0.525 indicating commercial traders were interested in getting some contracts bought. This tends to suggest continued support from solid demand, and in live cattle that usually means a firm cash market. A look at one source for cash market news tells me the market was unchanged at $110 (live) on heavy volume. However, notice how Feb lost ground to April, April slipped versus June, June weakened in relation to August, and so on. Selling was heaviest in February, with volume of 25,353 contracts, as the commercial continues to reflect the prospect of larger supplies over the winter based on the recent monthly Cattle on Feed reports including record placement during September. The weakness of the Feb 21 contract is nothing new as the Feb-April spread has been running at or below the previous 5-year low since early April 2020, only now the spread has been extended to near (-$4.00) this past Friday with the previous 5-year low for the week at (-$2.45).
This part of the discussion always reminds me of one of my favorite stories. I was originally hired by DTN to be the Grains Analyst, though I always wound up talking about all the other market sectors in my commentary. After numerous early pieces and analysis talking about spreads, Urban Lehner, the Editor in Chief at the time, stopped by my desk and told me the President of the company, an economist by trade, wanted to talk to me. The three of us settled in around the executive office table and the President opened the meeting by explaining his view that higher deferred prices were bullish as it showed the market was willing to pay more later. It was one of those moments in time when one gets to tell their boss, “No, you’re wrong”. I then proceeded to tell him higher deferred prices indicate the market is willing to pay less now, reflecting ample supply to meet demand. Soon after that, I became Senior Analyst for all commodity markets.
Another key story again involved Urban, as we traveled out of state to talk to a large market research firm known for its fundamental (supply and demand) analysis. Given that, its analysts were again mostly economists with a wide variety of degrees and letters attached to their titles (e.g. MBA, etc.). As before, we all gathered around a large conference table as I started in on my standard presentation of how the market shows us all we need to know about real market fundamentals and regurgitating USDA nonsense was a disservice to the agriculture industry. Let’s just say this particular group of USDA enthusiasts was initially seething, so quietly you could hear a pin drop on the carpeted floor. Then the angry questions started to fly. The one that sticks with me was, “So you are saying a market can’t rally if its forward curve is showing a strong carry?!” As you’ve likely guessed I told them that is not what I had said, for market opinions can diverge. I laid out the idea of the Rubber Band Disposition, explaining how the two sides (commercial and noncommercial) can go in opposite directions but ultimately the market will snap back to its fundamentals. That certainly seems to be the case with what is going on in live cattle these days as the noncommercial side continues to liquidate their net-long futures position.
Lastly, I want to go back to a heated debate from a year ago this past October 4. At the time the forward curve in soybean futures was bearish while the corn forward curve was more bullish. Another analyst made the statement, “Futures spreads are nothing more than a snapshot of a particular moment in time…” as he tried to make a bullish case for soybean fundamentals. I disagreed, vehemently, and yes the market fell more than $1.00 from October 2019 through April 2020, or six months, before soybean spreads turned bullish. Since then the November 2020 futures contract rallied $3.00 through its expiration this past Friday. A friend of mine, a long-time veteran trader in the various pits, recently said it perfectly, “Spreads are the canaries in the coal mines.”
Until next time,